Mortgage interest deductions for loans in excess of $1,000,000

May 11, 2011 by Mike Verville

Recently, the IRS released Rev. Rul. 2010-25 to address whether acquisition indebtedness incurred by a taxpayer to acquire, construct, or substantially improve a qualified residence can constitute home-equity indebtedness to the extent it exceeds $1 million.  In Rev. Rul. 2010-25, the IRS ruled that a taxpayer can deduct as qualified residence interest up to $1.1 million of the debt securing the purchase of a taxpayer’s principal residence.

Rev. Rul. 2010-25 gives an example in which an unmarried individual purchases a principal residence for $1,500,000 with a cash down payment of $300,000 and a bank loan of $1,200,000 secured by the residence.  In the example, the taxpayer pays interest that accrues on the indebtedness during that year, and there is no other debt outstanding that is secured by the principal residence.  Per Rev. Rul. 2010-25, the taxpayer may deduct the interest paid on the first $1 million of the original loan balance because it is considered acquisition indebtedness under Sec. 163(h)(3)(B). Under the ruling, pursuant to Sec. 163(h)(3)(C), the taxpayer may also deduct the interest paid on $100,000 of the remaining debt of $200,000 because the first $100,000 loan amount in excess of home acquisition indebtedness is considered home-equity indebtedness. Any interest on the remaining indebtedness of $100,000 is considered nondeductible personal interest under Sec. 163(h)(1) because it cannot be traced to any source other than the personal residence, which has already reached its limits.

Rev. Rul. 2010-25 clarifies a gray area that has for years plagued many CPAs.  This ruling may allow CPAs and Taxpayers that have taken this position in the past the opportunity to sleep a little easier at night!!

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